Hear no EVE, see no EVE
The Fed chastised SVB for poor rate-risk monitoring, but most US banks’ disclosures remain focused on earnings alone
As with the most illustrious of history’s financial collapses, Silicon Valley Bank’s implosion has been depicted as a tale of hubris. Yet rather than wilful arrogance, it is a different banking vice that emerges from the Federal Reserve’s chronicle of SVB’s failings: insouciance.
The bank buckled under the weight of the Fed’s interest rate hikes over the past 12 months, which devalued the assets on its balance sheet as market yields surged. It was a failure to manage what the Basel Committee on Banking Supervision calls interest rate risk in the banking book (IRRBB), which banks should monitor by simulating the impact of rate shifts on two key indicators: net interest income (NII) and economic value of equity (EVE).
EVE is – in the Basel Committee’s own words – “the net present value of notional repricing cashflows for the whole banking book, excluding the bank’s own equity capital.” EVE-based simulations aren’t a substitute for NII-based testing, rather they complement it, taking a longer-term view of the impact of rate shocks on cashflow generation.
In its post-mortem, the Fed chastised SVB’s management for its tunnel vision, saying it “was focused on a short-term view of [interest rate risk] through the NII metric and ignored potential longer-term negative impacts to earnings highlighted by the EVE metric.” Though the bank had nominal EVE limits in place, persistent breaches of which were communicated to the risk committee, “there is no evidence the full board” was aware of these.
SVB’s handling of IRRBB was particularly cavalier. Among other things, it conspicuously omitted EVE sensitivity figures from its Q4 2022 10-K filing with the Securities and Exchange Commission, despite having hitherto disclosed them every quarter.
But in disclosures for most US banks, the EVE measure keeps playing second fiddle to the NII outlook. Outside the global systemically important banks (G-Sibs), only 11 banks with $50 billion or more in assets disclosed EVE test results as of end-March. Another 11 referenced EVE-based controls without disclosing actual figures, with three not mentioning EVE at all.
The US’s implementation of Basel’s IRRBB rules does leave much to the discretion of executives, only requiring banks to use and disclose either metric, rather than both. Supervisory guidelines from the Office of the Comptroller of the Currency restricts Basel-like EVE testing to categories I and II organisations – the G-Sibs, plus Northern Trust.
Behind closed doors, US supervisors can and will ask banks to up their IRRBB monitoring game if necessary. However, unsealed correspondence between the Fed and SVB shows that while the regulator ordered the bank to overhaul its IRRBB models last November, it did not explicitly direct its attention to EVE – despite the findings in last month’s report.
US supervisors are no doubt more alert to the need to monitor IRRBB through multiple indicators than two months ago. But considering one of the main impediments to taking proactive measures around SVB, in the Fed’s own admission, was a lack of resources at the regulator, one has to wonder if the easiest step is not to finally mandate standardised, wider-encompassing IRRBB disclosures.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
More on Our take
BofA quants propose new model for when to hold, when to sell
Closed-form formula helps market-makers optimise exit strategies
Are regulators wrong to think of AT1s as debt?
Bank capital bonds face criticism. One answer might be to treat them as ‘fixed-income equity’
How Risk.net’s robots unlocked Ucits trade data
Machine learning tool helps reveal the largest European derivatives users – and who they trade with
Running the numbers on Barr’s Basel III endgame revisions
Fed vice-chair’s plan to ease capital requirements for big banks still lacks critical details
Another post-Libor rate aims to clear Iosco bar
After two rivals were slapped down by the benchmark overseer last year, will Axi fare differently?
Nvidia is growing up. It’s not settling down
Chip maker is a mega cap that doesn’t act like one
FX forwards dealers face added challenges in P&L analysis
Mark-out tools for forwards and swaps trading may not be a panacea
Can history resolve factor investors’ p-hacking questions?
Quants seek reassurance in the far distant past